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Elections, Investments and The Battle For Future Wealth

By: Daniel Amerman | Monday, March 4, 2013

There was a major battle that took place in the United States in November
of 2012, but it wasn't fought between the Republicans and the Democrats.

The result was an overwhelming victory - because only one side showed up for
the fight. For the most part, the other side didn't even realize that a battle
was being fought.

The winners came well-organized in their tens of millions. These were the
people who have been promised government benefits for Social Security and Medicare,
now and in the future. These were the people whose jobs are dependent on government
spending, and these were the people who are receiving transfer payments from
the government.

The casualties in this battle were the tens of millions of conventional long
term investors and retirement investors, who in many cases had been responsibly
saving and producing more than they consumed for decades, building a nest egg
to take them through retirement with security.

What decided the outcome was a lack of knowledge, as most of the people whose
future standard of living will likely be slashed by what was being decided
in the election were not even aware that a battle was being fought. So the
battle was over in a rout before the election was even held, as long-term
investors lacked even the basic choice of being able to vote to defend what
they have been building.

No Contest

Now there are many millions of people who would likely disagree with this
assertion that there was no battle, or that it was effectively over before
it began. They might say that the election was indeed about what the future
role and size of government should be, and that it was actually a very hard
fought election, whose outcome ended up being decided by a very small margin
if one were to look at key battleground states.

And there is truth to that statement, as a matter of political philosophy.
However, when it comes down to the actual specifics of what was being voted
on in the election as they relate to the division of wealth in the future between
private investors and government beneficiaries, some of the key issues
weren't even on the table to be voted upon. That is because in their search
for votes, the candidates weren't disagreeing with each other on these critical
issues for long-term investors.

The Division Of Limited Wealth

When it comes to long term investment success for the average investor in
the future, perhaps the most central of all questions pertains to the division
of limited wealth.

The United States has a number of different programs that are destined to
become extraordinarily expensive - far more so than they are today - just with
the inevitable demographic factors of there being more and more Boomers reaching
retirement age and relying upon Social Security and Medicare, even while there
are proportionately fewer workers in the labor pool to support them.

According to recent calculations by Archer and Cox, the former chairman of
the House Budget Committee and the former head of the SEC, the real total deficit
is approximately $87 trillion - not $16 trillion as official government
numbers indicate - and the amount of unfunded obligations is growing by a rate
of approximately $7 trillion a year. Which means that the real annual deficit,
if we don't use governmental accounting gimmickry, is over $8 trillion a year
- instead of over $1 trillion per year.

Now the issue with wealth is that there's only so much real wealth available
in the form of goods and services, regardless of all the financial games that
are played with the compounding of paper wealth. Either the goods and services
are there to support people, or they aren't.

When we look at Social Security, Medicare and most financial planning, the
assumptions are that economic growth rates will be normal compared to the past.
As discussed in my previous articles such as "Three
Converging Factors May Slash Economic Growth By 71%", there's a
very strong case to be made that that will not turn out to be the case. But
regardless of whether the future is one of normal economic growth, low growth
or no growth, it will not change the basic fact that there is only a limited
number of resources available.

And if we take the extraordinary future cost for these governmental programs
and say that there's only so much wealth available to be split among government
beneficiaries, the then current producers of real goods and services, and those
who are planning on supporting themselves through the sale of retirement investments,
then we start to realize we may have a serious issue there.

Here is a basic but essential question: If the government beneficiaries are
taking the lion's share of what is available, and indeed locking that into
the law, even while the younger generations who are still actively employed
are struggling to maintain their own lifestyles while bearing the extraordinary
expenses of those promises, then where does the real wealth in the form
of resources come from to cash out the trillions of dollars in retirement wealth
that pension funds and tens of millions of retirement investors are counting
on?

You can't cash out what isn't there. And if we have an extraordinary growth
in government spending that greatly exceeds the rate of national economic growth,
then the private sector must necessarily have a reduced growth rate, and investors
cash out much less of the wealth of the future than they had anticipated. This
issue of how a government's rising share of the economy cripples private sector
growth rates (which conventional long-term investing absolutely relies upon)
is explored in more detail in my article, "High
Government Deficits 'Crowd Out' Stock Market Returns".

Now when it came down to the US elections in 2012, what is crucial to note
is not so much where the differences were, but where the differences weren't.
That is, neither candidate dared to talk about cutting government benefits
to retirees, at least not for a very long time to come.

Neither one dared even consider discussing the possibility of reduced benefits
for those who are currently older, because they knew it would be the equivalent
of a political death penalty to do so. The average American voter, for what
they believe to be very good and fair cause, wants what was promised to them.
They want what they have been making their payroll tax payments upon for decades
now, and they will not stand for having that taken away from them - at least,
not openly.

So despite the philosophical debate about lesser or greater governmental spending
growth, when it came down to the actual specifics of what this nation does
about an impossible level of future promises that would essentially consume
the economy, that issue was not even on the table. Because the voters wouldn't
let it be there.

The Political Redistribution Of Wealth

For all long-term investors, there was another critically important issue
that again was not even discussed by either party in their election campaigns.

The fundamental situation is that tens of millions of people, either directly
through their investment portfolios and/or retirement accounts, or through
their pension funds, are investing long-term based upon certain assumptions
when it comes to the compounding of wealth.

At the heart of the issue -- and something that has been built into financial
and retirement planning models for decades -- is the assumed payment of normal
interest on bonds, money market funds, certificates of deposit and other financial
instruments. It has been built right into the assumptions the entire time that
we're all going to get interest payments that are significant enough to be
used to both compound the value of our investments during our savings years,
and to provide us the cash to support our lifestyle in retirement.

Indeed when we look at the classic "Investment Life-Cycle" approach to financial
planning, then the older an investor gets, the more of their money that should
be in fixed income investments, particularly as they approach retirement age.
This is because modern financial theory holds that these substantial interest
payments are in fact more reliable than stock market appreciation, at least
in the short term.

The problem, however, is that there is a gaping hole in this theoretical model.
For when it comes to the real world, interest rates are near 0% as a matter
of deliberate government policy, and there are near continuous massive market
interventions by the Federal Reserve to make sure that those relying upon interest
income won't get any to speak of.

In other words, as a political decision, the federal government has effectively
destroyed one of the very foundations of conventional investing and retirement
planning.

For those who are familiar with the term -- and I have written about it extensively
-- this is one crucial aspect of Financial
Repression. Financial Repression is effectively a hidden tax that
the government uses to take wealth from investors on a wholesale basis. As
covered in my article linked below, this hidden tax currently redistributes
more than $500 billion a year from savers to the government - lowering standards
of living even while it cripples investment performance.

Now again, this critical issue was not even discussed by either major candidate
in the debates. Here we have government interventions destroying the very foundation
of long-term financial investment and retirement planning, but this deliberate
government policy was not even on the agenda for voters to weigh in on during
the election.

This is straight-up political distribution and redistribution of wealth on
a massive basis from investors to the government. But because the public does
not understand what is being done, it is not a campaign issue, and there is
no way to vote against it.

Modern Investment Theory & Unconditional Surrender

So we have a situation where the wealth of the future is being grabbed by
law, with overwhelming voter support, to the extent where it's difficult to
see how the real resources of goods and services could possibly be available
to support conventional retirement investors with the lifestyles that they
assume they will be able to enjoy.

Simultaneously we have deliberate governmental policy devastating the very
foundations of financial and retirement planning, destroying the strategy underlying
decades of savings for tens of millions of people all across the country -
and yet, this government policy is not even a subject for election debates.

What is going on, and why aren't investors defending themselves?

Let me suggest that there are two major reasons why this is not controversial
within the investment community, and why investors are not rising up in the
tens of millions to do battle on these issues that are so vital for their financial
futures.

The core of the problem is that financial planning is based on modern investment
theory, and this academic theory does not recognize the concept of limited
wealth. Built into the models - and this is something that I have been in vigorous
disagreement with my peer group for the last 20 years - is effectively unlimited
wealth. That is, investor wealth is held to compound in isolation, and is not
limited by the rate of economic growth, nor by other claims to that same limited
wealth. It is just not allowed for in the models.

By definition, modern investment theory is blind to the possibilities of a
scarcity of resources, or to the effects of other groups competing for that
same wealth.

That brings us to the other major problem, which is that of politics trumping
investment theory. That's what we see right now every time someone buys a bond,
puts money in an interest-bearing checking account or puts money into a money
market fund. They should be getting a higher rate of return than they are,
but as a result of Federal Reserve policy, they make a near zero interest return
on their investment. Which is destroying the very fundamentals of conventional
financial planning and having a direct effect on the standard of living in
retirement as well the actual age at which retirement is occurring for tens
of millions of people in the real world.

When it comes to the distribution and redistribution of wealth, modern investment
theory does not recognize the concept of politics trumping finance, but rather
it is blind to it. Modern investment theory does not allow for political actions
deliberately overriding the assumptions upon which that theory is based, even
as the dominant force in today's financial world is that of politics overruling
investment theory.

Battlefield Versus Clover Field

Daniel R. Amerman is a financial futurist, author, speaker, and consultant
with over 20 years of financial industry experience. He is a Chartered Financial
Analyst (CFA), and holds MBA and BSBA degrees in Finance from the University
of Missouri. He has spent seven years developing a large, unique and intertwined
body of work, that is devoted to using the foundation principles of economics
and finance to try to understand the retirement of the Baby Boom from the perspective
of the people who will be paying for it.

Since 1990, Mr. Amerman has provided specialized quantitative consulting services
to financial institutions, with a particular emphasis on structured finance.
Previously, Mr. Amerman was vice president of an institutional investment bank,
with responsibilities including research, synthetic securities, and capital
market originations.

Two of Mr. Amerman's previous books on finance were published by major business
publishers. "COLLATERALIZED MORTGAGE OBLIGATIONS, Unlock The Secrets Of Mortgage
Derivatives", was published by McGraw-Hill in 1995. Mr. Amerman is also the
author of "MORTGAGE SECURITIES: The High-Yield Alternative To CDs, The Low-Risk
Alternative To Stocks", which was published by Probus Publishing (now a McGraw-Hill
subsidiary) in 1993. Advertised by the publisher as a professional "bestseller" for
four quarters, an Asian edition was sold as well.

Mr. Amerman has spoken at numerous professional seminars and conferences nationwide,
for a variety of sponsors including New York University, the Institute for
International Research, and many others. After the publication of his prior
books, he acted as keynote speaker at a number of banking related conferences
over the next several years.

This article contains the ideas and opinions of the author. It is a conceptual
exploration of general economic principles, and how people may - or may not
- interact in the future. As with any discussion of the future, there cannot
be any absolute certainty. What this article does not contain is specific investment,
legal or any other form of professional advice. If specific advice is needed,
it should be sought from an appropriate professional. Any liability, responsibility
or warranty for the results of the application of principles contained in the
website, pamphlets, videos, books and other products, either directly or indirectly,
are expressly disclaimed by the author.